I don’t get it. I’ve got a new product proposal that can’t help but make money, and top management turns thumbs down. No matter how we price this new item, we expect to make $130,000 on it pretax. That would contribute over ten cents per share to our earnings after taxes, which is more than the 9-cent earnings-per-share increase last year that the president make such a big thing about in the shareholders’ annual report. it just doesn’t make sense for the president to be touting e.p.s. while his subordinates are rejecting profitable projects like this one.
The frustrated speaker was Sarah McNeil, product development manager of the Consumer Products Division of Enager Industries, Inc. Enager was a relatively young company, which had grown rapidly to its current sales level of over $74 million. (See exhibits 1-3 for financial data).
Enager had three divisions, Consumer Products, Industrial Products, and Professional Services, each of which accounted for about one third of total sales. Consumer Products, the oldest division, designed, manufactured, and marketed a line of houseware items, primarily for use in the kitchen. The Industrial Products Division built one-of-a-kind machine tools to customer specifications; i.e., it was a large “Job shop,” with the typical job taking several months to complete. The Professional Services Division, the newest of the three, had been added to Enager by acquiring a large firm that provided land planning, landscape architecture, structural architecture, and consulting engineering services. This division had grown rapidly in part because of its capability to perform “environmental impact” studies, as required by law on many new land development projects.
Because of the differing nature of their activities, each division was treated as an essentially independent company. There were only a few corporate-level managers and staff people, whose job was to coordinate the activities of the three divisions. One aspect of this coordination was that all new project proposals requiring investment in excess of $500,000 had to be reviewed by the corporate vice president of finance, Henry Hubbard. It was Hubbard who had recently rejected McNeil’s new product proposal, the essentials of which are shown in Exhibit 4.
Prior to last year, each division had been treated as a profit center, with annual division profit budgets negotiated between the president and the respective division general managers. At that time, Enager’s president, Carl Randall, had become concerned about high interest rates and their impact on the company’s profitability. At the urging of Henry Hubbard, Randall had decided to begin treating each division as an investment center so as to be able to relate each division’s profit to the assets it used to generate its profits.
Starting in last year, each division was measured based on its return on assets, which was defined to be the division’s net income divided by its total assets. Net income for a division was calculated by taking its “direct income before taxes” and then subtracting its share of corporate administrative expenses (allocated on the basis of divisional revenues) and its share of income tax expense (the tax rate applied to the division’s “direct income taxes” after subtraction of the . . .
- Why was McNeil’s new product proposal rejected? Should it have been?
- Evaluate the manner in which Randall and Hubbard have implemented their investment center concept. What pitfalls did they apparently not anticipate?
- What, if anything, should Randall do now with regard to his investment center approach?